Stock Market -- what a difference a couple of days makes

Big Man wrote:

So peeps do you have a comeback for Flagpole?? You are against all of his advice and investing. Do you think we should all just buy gold and do nothing else with our money excpet spend it? I would be curious to hear your insight?

Flagpole has told me his opinion and I agree with a lot of it. I also take into consideration the inflation that you are bringing up. That is crucial. But you still don't answer the question as to what you would advise. Just accept that we are all doomed and spend our money??

Big Man, there are some things you need to know about I Love Peeps:

1) He IS for buying gold. He has stated he's a buy gold and head for the hills with a gun kind of guy. I suspect the head for the hills with a gun thing is just for effect, but if he is to be believed, he really thinks Gold is a good investment. [note: precious metals aren't an investment; that is gambling pure and simple. Speculating is NOT what smart long term investors should do.]

2) He is also for buying individual stocks over mutual funds. Why? I have no idea. That is why I mentioned that DNDN was at 4.85 yesterday. He bought a bunch of it at 15. Expecting a big rise from there. It went up a little before plummeting. Individual stocks are also gambling.

Now, I'm not against individual stocks completely, but I think you should only buy individual stocks if the following is already true:

1) You have 6 months of expenses saved in a liquid account (Money Market Account, non-retirement mutual fund, or even an interest bearing savings account; to goal here is NOT to make money on this money, but to have it for an emergency, so if you make a little on it, then fine).

2) You are maxing out your 401k and Roth IRA ($15,500 for 401k and $4,000 for IRA if under age 50; totals go up in 2008).

3) You own your home outright.

4) You have no debt whatsoever -- no credit cards, no car loans, no student loans...nothing.

THEN, if you are continuing to do all of that (meaning you continue to stay out of debt), and you want to try some luck with individual stocks with money you don't need to pay bills, then go ahead. You can make a killing with individual stocks, but you can lose your shirt too which is why I always say to be in diversified mutual funds (mostly growth stock mutual funds if you're under age 50) in your 401k and Roth IRA.

Now, personally for me, I don't invest in individual stocks and would never. I don't yet own my home outright, but once I do, I will throw extra money into my non-retirement mutual fund rather than buy individual stocks.

Don't let I Love Peeps scare you regarding inflation.

If from age 23 to age 60 you invest $235,000 (10,000 per year for the first 10 years and just 5,000 per year after that) in your retirement accounts, at a conservative 9% annual return, you will end up with $2.25 million dollars.

Then at age 60 if you begin to take 5% from it (while making maybe 6% in VERY conservative investments) you will have $112,500 per year. Just two years after than you can tak Social Security also which will be at LEAST $20,000 more per year, and since it goes up with inflation, it will be more than that.

In my example above, for the last 27 years, the investor only put in $5,000 per year, or just 10% of a 50,000 salary. Can you imagine doing more than 10%? Can you imagine making more than $50,000 during those 20 years? The way you beat inflation to death is invest a ton early on, and continue to do so...as much as you can bear. Be debt free too so that you aren't paying a ton toward interest -- this will make your life easier and you'll actually have spendable cash too in addition to all you put in retirement.

Buy and hold for the long run brother. It will make you rich.

Now, some people are of the idea that you shouldn't die with a ton of money. Ok then. If your investements do REALLY well and you have 2 million dollars at age 52, then retire then and go live a little (of course you will pay a 10% penalty for taking money out earlier than 59 1/2 IN MOST CASES, so you might want to wait until age 59 1/2, but man, you could quit contributing to retirement accounts at 52, take a part time job, and have a blast the last 7 years before you retire for good.

Flagpole, your fear of individual stocks is grossly exaggerated.

With a random selection of 14 stocks or so 90% of the effect of a fully diversified portfolio is achieved. If you hold 20 or so stocks you will pretty consistently match the market. Modern portfolio theory has some instructive math, Markowitz, Merton & Sharpe won the Nobel prize for this. Your personal ideas about market diversification follow directly from their work.

For after-tax accounts it is much easier to control tax effects with individual stocks. In the portfolios I control we generally buy mutual funds for pre-tax money, individual stocks for at least a portion of after-tax money. I don't claim to pe a stock picker, but holding a portfolio of stocks has little more risk than owning the market itself, if you are a buy and hold investor you also end up saving the 25-50 bps yearly fee so it can actually be cheaper than owning a fund. My personal experience over the past 30 years reflects this.

That said, your advice to "buy and hold for the long-run" is sound. For many individual investors the best way to do this IS with mutual funds. But your advice regarding individual stocks is typically over-the-top, a little hysterical.

For a true investor (rather than speculator) stocks have been the best inflation hedge of all over time. Peeps is a pure speculator, if his market views turn out to be correct he may outperform, but he also faces (by definition) an increased downside risk. So be it, we all have different risk attitudes.

you might want to take a closer look at the stocks held by the funds in your portfolio. If you are wildly outperforming during a specific period, a future period of equally wild underperformance should not be unexpected.

We have had an ~8% position for the past 1.5 years or so in TIPS, it has moved smartly in anticipation of some serious inflation on the horizon. I am expecting a period of market uncertainty over the next 2-3 years, fallout from the unbelievably misguided rule of the Bush administration.

I'm 24 with a college degree and no debt (full-tuition scholarship, worked summer jobs to pay expenses during the year). I'm currently spottily employed--working a part-time non-paid internship and a part-time job to pay the bills, but I'm very good about saving my money.

I own (but rarely drive) a 1980s car, have maxed out my Roth IRA the last 3 years (invested the max amount), and currently have $8K in the bank. At what point does it become better to buy instead of rent?

Gasbag,

Your idea of buying 14 stocks is something I could live with. In effect you are creating your own mutual fund. Some people though get a "hot tip" and so they buy a lot of one specific stock. That's not something I want to do. I know it is possible to make a killing if things go well, but that killing can come over time with consistent investing too. I never really trust the character of people who want something for nothing -- regular lottery players, single stock pick gamblers, big time casino gamblers, etc. There's nothing wrong with making it big in some quick unexpected way, but for some reason those that plan for it never seem to have the highest moral character on average from what I've seen. You invent something that makes you filthy rich immediately then fine. You start a company that is a huge success, then fine. You spend $32 a week on lottery tickets and make that your plan to financial freedom, then not so fine.

Flagpole, in my opinion you offer smart long-term advice for most investors. However, to me, there is a difference between pure speculation/gambling as you call it and a tolerance for high levels of risk. Now, the average investor is not smarter than the market as a whole, and is more than likely unwilling to accept the high risk levels associated with individual stocks etc.. That being said, my portfolio is overweighted (but not completely invested) in a couple of individual stocks. I've maxed out my 401k this year. For my after-tax savings I am generally willing to take on very high risk levels. You may view this as the same as buying a lottery ticket, but while I understand your position, I don't tink it's quite the same thing.

wittiness here wrote:

I'm 24 with a college degree and no debt (full-tuition scholarship, worked summer jobs to pay expenses during the year). I'm currently spottily employed--working a part-time non-paid internship and a part-time job to pay the bills, but I'm very good about saving my money.

I own (but rarely drive) a 1980s car, have maxed out my Roth IRA the last 3 years (invested the max amount), and currently have $8K in the bank. At what point does it become better to buy instead of rent?

Hmmm. You're in a better position than most. I like the maxed out Roth IRA, but that is only $4,000 per year after all. Can you get a full-time job with a 401k and health benefits? Once you do that, if you want to go buy a house with a 15-year fixed rate mortgage that is no more per month than 25% of your takehome pay (or very close to that), then I say go for it. they say housing prices may continue to drop for another year but most are calling homes very cheap right now also. Get that full-time job, make sure to put enough into your 401k to get the full company match, continue with that Roth IRA maxing, and keep adding to your 401k contribution until you one day can get it up to the max allowed ($15,500 for 2007). You want to buy a house though after you get a full-time job, then I've got no problem with that.

orexcguy wrote:

Flagpole, in my opinion you offer smart long-term advice for most investors. However, to me, there is a difference between pure speculation/gambling as you call it and a tolerance for high levels of risk. Now, the average investor is not smarter than the market as a whole, and is more than likely unwilling to accept the high risk levels associated with individual stocks etc.. That being said, my portfolio is overweighted (but not completely invested) in a couple of individual stocks. I've maxed out my 401k this year. For my after-tax savings I am generally willing to take on very high risk levels. You may view this as the same as buying a lottery ticket, but while I understand your position, I don't tink it's quite the same thing.

If you've maxed out your 401k and still have money to burn, then I don't have a big issue with you spending money on a couple of individual stocks. Like I said, I would never do it, but contrary to popular belief here, I'm ok with things that other people do that I wouldn't do; meaning even though I wouldn't do it, I don't think you're stupid for doing it. If you can stomach the possible losses, then go right ahead (especially since you are already maxing out your 401k). I would hope that you are also debt free (except for the house which you are close to owning outright), but hey, if you are happy with your financial choices and direction, then who am I to argue.

My main problem really is that I don't see why someone with debt and no retirement savings would throw a ton of money into a stock or two. People do that all the time hoping for the big score, and they get burned by it all the time. i worked for a company once whose stock went up to 32. People had the copany match their 401k in company stock (when they had other options). They felt great when it was at 32, but then like a stone if dropped down below a dollar, and the company was sold. That kind of thing happens a lot.

So, again, if someone were to ask me when the should buy an individual stock or two, I would tell them to be debt free, maxing out retirement accounts, own their house and THEN do it. Even when I get to that point, I won't do it though. My mutual funds are doing well enough to get me to where I want to be.

Flagpole, I have read you like to listen to Bob Brinker. His rule of thumb is for people not to invest more than 4% of their portfolio into a single stock. His advice isn't not to invest in individual stocks.

I own only two individual stocks and they both are under 4% of my portfolio. There is added risk in holding individual equities since you are taking on market risk along with the individual stock risk. I feel the potential reward for these two stocks are worth the risk.

The rule of thumb rule Brinker has is so people won't overweight stocks and if they have own stocks they will have to own about 25, which will make for a diversified portfolio.

Tell me more about TIPS.

I understand what they are: you get a fixed rate of payment and a variable rate based upon CPI.

But what drives the fixed rate portion? I figure if the fixed rate is above 2.5% there is little need to buy traditional bonds. But I cannot figure out what kind of environment would drive the fixed portion that high.

Do you buy individual TIPS and own them until they mature? What do you think of TIPS funds?

Cash is your worst investment right now. Inflation is going to continue and you are losing money as you hold cash.

I would suggest a preferred stock over a cd or money market. These are yeilding a better rate than money markets and are relatively safe.

Ok so I have told you that I\\\'ll have approx. 40,000 in college loans with me and my girlfriend combined.

Would you suggest knockig this out first and then start to invest in mutual funds? Not knowing how much we will bring in makes it difficult to say I understand. But I\\\'m pretty certain I don\\\'t have a good interest rate on my college loans. I was 18 and didn\\\'t know what to do so just got some loans at too high of an interest rate. Do I pay that first and then move to inesting?

I saw from your stats that it\\\'s important to start early but I may be better off getting rid of the debt first.

also how do I start investing in a mutual fund??

Flagpole, believe or not some people put effort into picking individual stocks. They are not these risky ventures that you seem to believe. Successful investors can follow a company for up to a year, study they're management and growth possibilities and the possible market for there product/service. Just because you can't put in the effort to do the same thing doesnt mean it is wrong. YOU are trusting a fund manager to pick stocks for you. How stupid does that sound? Do it yourself. Instead of picking the best coach for a team how about actually coaching the team yourself? Hiding your lack of knowledge concerning the market is cowardly. If you dont want to become a student of investing then dont, but stop trying to tell other people that they cant do it. Not everyone is as lazy and simple-minded as you. The market is a place to make more out of your income then what you've got. if you want to be more "secure" then get a better income and be frugal. If you want to make your money really work for you, not just building money for when your 60, then put in the effort. Its not risky, its simply doing an extremely substantial amount of work for a solid reward.

"Inflation is going to continue"

This is true but what do you think the inflation rate is right now?

Depends on what the rates are on the loans. If you have some rates around 4-5%, I wouldn't rush paying those off, as you can make more on average in the market. If the rates are anywhere over 8%, you should definitely pay those off ASAP.

want some info wrote:

Tell me more about TIPS.

I understand what they are: you get a fixed rate of payment and a variable rate based upon CPI.

But what drives the fixed rate portion? I figure if the fixed rate is above 2.5% there is little need to buy traditional bonds. But I cannot figure out what kind of environment would drive the fixed portion that high.

Do you buy individual TIPS and own them until they mature? What do you think of TIPS funds?

The fixed coupon is a market rate, set at the auction, give or take some % from par. It represents what buyers are willing to pay for the expected future cash flows, the known fixed coupon plus the CPI adjusted principal payout at maturity. So the fixed coupon approximates the real rate of interest.

TIPS are all about inflation expectations. If inflation going forward is higher than expected, TIPS outperform bonds. If lower, TIPS underperform bonds. If actual inflation equals expected inflation TIPS and bonds are sort of a toss-up, but the TIPS spread shows some incremental return to nominal bond holders, presumably for taking inflation risk.

I only own TIPS in tax free accounts, the phantom tax on the CPI adjustment is annoying. The funds are fine, it's pretty easy and cheap to own individual securities. but with less than 50k or so probably not worth the effort.

So if you want to inderstand TIPS investing you need a handle on real and nominal interest rates, and how the market develops inflation expectations.

Well said. There's nothing wrong with putting all your eggs in one basket as long as you watch the basket closely.

Pretty much debt free (non-mortgage), but only have about 50% equity in the house.

I'm a little more pessimistic on the market right now than I gather you are, but as a whole I don't disagree with any of your long-term investing advice. I just think we have different risk tolerances. I can more than understand your position about mutual funds etc.. The problem with most people who invest in individual stocks is they want the potential for big gains with none of the risk. They may say they are prepared for the loss potential, but when it actually happens they aren't. The first time I had an individual stock tank that was the case for me (at least at the dollar amount invested) and I suspect that is true for a lot of people that invest in individual stocks.

Thanks for the response.

I know the fixed rate is determined by the market. But what market environment is the fixed rate likely to increase?

If expected inflation is going to be low, I would think the market would drive up the fixed portion. But I thought the fixed portion has been going down to about 1.5%.

Good point about holding TIPS in a tax advantaged account. I agree with that one. But can you buy individual TIPS directly in an IRA or Roth IRA?

I'm about the most risk tolerant person I know regarding investment, and I can't disagree more with what you're saying. Anyone that buys mutual funds knows that most involve a bundle of individual stocks. The decreased overall risk comes from spreading out the risk specific to each stock over the entire fund. What Flagpole is saying is anytime you concentrate more (percentage wise) of your investment in a single company it becomes more risky. No amount of research and due dilligence can change this fact. If a lot of research was all that was needed to drastically outperform the market a lot more funds would kill the indexes every year. As you say, a substantial amount of work can come with a solid reward, but when you're putting a higher percentage into individual stocks that inherently comes with accepting higher risk. Plus, that assumes that your research and hard work is better than the paid people on Wall Street doing the same research and work. I'm not a believer in a truly efficient market, but it's not so inefficient that research can make owning individual stocks not risky.